As some of you might know, we recently made the decision to purchase a condominium. As the unit is still under construction, we won’t be able to move in until sometime in January. The long period of delivery posed a problem when attempting to get a mortgage approval from traditional places such as ING Direct, so we got the approval done with the builder’s associated bank. This streamlined the process, and provided us with two options to take in January:
- A 3 year fixed rate mortgage at 3.15%.
- A 5 year variable rate mortgage at prime – 0.3%. With the recent bump in prime rates to 2.75%, this means that the variable rate would currently stand at 2.45%.
The predicament
We currently have the choice of taking the three year fixed rate mortgage, at 3.15%, or the five year variable rate mortgage, at 2.45%. This rate could still increase between now and January.
The advantage of taking the fixed rate is that it provides insurance against interest rates going up by more than 0.70% over the three years, as well as emotional peace of mind from the stability of the rate. In order for the two to break even, however, the rates would have to go up by even more than that, because for a period of time we will be paying down the mortgage faster with the variable rate.
There is also the alternative of renegotiating the variable rate as we get closer to the closing date. I have read about others getting prime rate – 0.6%, so it would seem that prime – 0.3% is not a very good deal at all.
My thoughts
I haven’t yet crunched the numbers for this specific scenario, but I don’t quite see rates rising by more than 1% from 2011 to 2014. I could be wrong, of course, but I still see too much weakness in the global economy, overall. Even if we go for the fixed rate and rates somehow skyrocket, we’ll still have to pay the piper his dues once the three years are up. Past analyses have favored the variable rate, and I am still quite partial to taking a variable rate in January. Either way, it looks like mortgage rates are going up, and we’re going to have to accept that.
I will be asking my mortgage advisor to prepare a new amortization chart for us as we near the closing date. An amortization chart is one good way of analyzing the differences between a fixed rate versus a variable rate, over the period of time being considered. Most mortgage advisors will prepare this for you upon request. If one option results in a lower balance at the end of the term, the monthly payments being equal in either case, then that option could make more sense for you.
So, what do you guys think? Are we getting shafted on our variable rate? Although the 3 year fixed rate is slowly looking more attractive, is it still a ripoff? Which option is more likely to increase our expected value? Please let me know what you think!
I would go with the 3 year rate and just be careful not to take on too much debt. I believe rates can go up by more than 1% by 2014 but then again if you asked me 6 months ago I would have predicted higher rates than we’re seeing today. I believe when rates move higher they are likely to move fast. On the other side of the coin is the possibility of deflation and lower rates over the next couple of years. If this happens then you can jump on the 3 year rate at that point and possibly lock in lower rates for the first 5 years of your mortgage.
Too bad they don’t offer 50/50 – half variable, half fixed.
The key I think is to ask if you can afford your payment if the rate goes as high as 5 – 6%! You are in a really good environment to take on a mortgage at low rates. I assume you got a great price on your condominium as well. If you were in the U.S. I would recommend a 30 year mortgage and just be done with it!
Come to think of it, maybe a 1% hike by 2014 isn’t that unreasonable. If I was by myself, I think I’d still take the chance and go with variable, but with the fact of a significant other to think about, as well as sleeping at night, the difference might be close enough to go with fixed.
Yeah, it’s too bad we don’t have the option of the long fixed mortgage here; I hear the rates down south are very good! We can afford at 5%-6%, but then it starts to slowly break the 33% of net income rule I set for us. We are still very close to there even at 6%, but if it goes higher than that, it will become quite expensive for us.
Kevin,
You can always split the mortgage into variable and fixed parts. Also remember that you will have to pay the piper once refinancing is up so if you can go with a variable rate conditional to paying lump sum payments for the next 3 years you will come out ahead no matter what the rates do in the next 3 years!
Good luck with your decision 🙂
Hey Mich! It depends on a lot of unknowns; the fixed rate might be a way of smoothing out a bit of uncertainty until we see how things are in three years from now. I would probably jump onto variable at that point if I don’t jump on it right away, as I can’t see myself going for 7% 5-year fixed.
Kevin, If you are going to be in the home for more than a few years, go for a fixed for the term of 15-30 years. (Or consider a variable with a fixed term of 8-10 years). With interest rates at 50 year lows, the chance to lock in low mortgages rates for a longer term is GOLD. Congrats and good luck, Barb
Hi Barb,
I’ve heard that you guys down south are getting some pretty good deals these days. Unfortunately, the longest term available here is 10 years and a ripoff, and even the 5-year fixed at near 6% is also a ripoff! No mortgage interest deduction, either.
I too, would go with the 3-year rate. Can rates really stay this low…? I’m thinking no. If you get your 3.15, and rates go up 1% over the next 3 years of your term, you’d be ahead. This is quite likely. If not, and rates only go up 0.25 or 0.50 basis points, you’re still not that far off. With the 3-year term, you don’t have to rate-watch and you can focus on more things to invest wisely 🙂
BTW – is that the future view from your condo? Sweet if so!!
The truth is actually a bit more complicated than that, as let’s say the rate went above 3.15% halfway in. It would then have to rise somewhat more than that in order for the variable rate to end up as expensive as the fixed rate, since I had a discount up to this point.
However, there is not such a big difference in the spread, and the security of the fixed rate in terms of sleeping at night and such is looking more appealing, and you are very right in that regard. We’ll have to reevaluate as we get closer to the closing date.
P.S., nope, not our view! I wish 😛 I just thought it was a nice complement to the article 😉
It really depends on your comfort level. CanEquity has a nice graph comparing the prime rate and 5 year fixed rate over the past 10 years. The prime rate can move much more than 1% in 3 years.
I have to say that with a fixed term, you can blend and extend easily without breaking it and paying fees. Understand what your options are with the variable rate. Do you get a fixed discount on converting to a fixed term? What’s the cost for breaking it?
I picked a 3 year term when I bought my first place. There are so many expenses to incur in the first year and if your finances are tight, any increase in payment due to rate increase may be felt. For example, will the family grow? Variable rates only seem to offer 5 year terms but I am against long term rates. 3 year is the max I have had. It’s easier to take advantage of market dip by doing a blend and extend at any point. I’ll spare the details but I wrote about it on my blog. It’s all about the savings that a lower interest has on your amortization now! Rather than feeling safe.
Use a mortgage calculator to test scenarios. There are plenty of free ones on the web and at the banks. Run the different scenarios. I agree with you that the amortization is a good way to evaluate where you land. With either choice, keep on monitoring the rates and adjusting course. I started with a 25 year term and after 5 years I have just under 14 years left. Making bi-weekly payment is big on amortization. Then I just happen to be able to reduce my rate while keeping the same payment. (Essentially increasing my payments without making the increase).
The Money Gardener had an interesting view on paying his mortgage. Depending on your comfort level and goals, that may be something to consider.
“It really depends on your comfort level. CanEquity has a nice graph comparing the prime rate and 5 year fixed rate over the past 10 years. The prime rate can move much more than 1% in 3 years.”
That is a good point.
“I have to say that with a fixed term, you can blend and extend easily without breaking it and paying fees. Understand what your options are with the variable rate. Do you get a fixed discount on converting to a fixed term? What’s the cost for breaking it?”
I did discuss this with the mortgage advisor, and how I understood it was that if we decided to switch from a variable rate to a fixed rate, we would get the fixed rate available at that time, minus the bank’s standard discount.
“I picked a 3 year term when I bought my first place. There are so many expenses to incur in the first year and if your finances are tight, any increase in payment due to rate increase may be felt. For example, will the family grow? Variable rates only seem to offer 5 year terms but I am against long term rates. 3 year is the max I have had. It’s easier to take advantage of market dip by doing a blend and extend at any point. I’ll spare the details but I wrote about it on my blog. It’s all about the savings that a lower interest has on your amortization now! Rather than feeling safe.”
That’s true; we’re going to be buying some furniture and probably a new TV as well. I’ll go search for that article on your blog!
“Use a mortgage calculator to test scenarios. There are plenty of free ones on the web and at the banks. Run the different scenarios. I agree with you that the amortization is a good way to evaluate where you land. With either choice, keep on monitoring the rates and adjusting course. I started with a 25 year term and after 5 years I have just under 14 years left. Making bi-weekly payment is big on amortization. Then I just happen to be able to reduce my rate while keeping the same payment. (Essentially increasing my payments without making the increase).
The Money Gardener had an interesting view on paying his mortgage. Depending on your comfort level and goals, that may be something to consider.”
We are also going to go for the bi-weekly payments, as well as additional lump sums when the opportunity is there (i.e. work bonuses). I also want to work on building up investment assets and passive income over time, so I’ll likely take a balanced approach here.
Thanks for the detailed reply, you have given me some good points to think about and consider!
I vote for fixed rate- no more than a 20 year loan at max. 15 year is better if you can do the payment. A 15 year loans saves you tons of money over time.
Unfortunately those kinds of options don’t exist up here. The longest you can reasonably hedge interest rates is for 5 years, and even our 5 year rates tend to be ripoffs. It’s a slightly different ball-game up here 😉
I always vote fixed rate…I like the peace of mind.
I think I might have been proven to be a little silly in my optimistic <1% increase from 2011-2014. If the rates go up another 0.25% before the end of the year, I think we'll probably go with the 3-year fixed for sure.
All I gotta say is DAMN those are some cheap rates!
I’d just go for the 3 year fixed. No points?
Not sure what you mean by points? They are cheap rates, but they are for very short terms! No such thing as a 15-year or 30-year fixed, here! You guys with 4% or so will be laughing at us in a few years if rates get jacked up 🙂
Anyone else thinking of re-financing the mortgage at the new low rates this morning? I’m seeing some 5.30 APRs for 30yr fixed w/ 0 points.
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